What Is a Licensing Agreement?

A licensing agreement is a written contract between two parties in which a property owner permits another party to use that property under a specific set of parameters. A licensing agreement or license agreement typically involves a licensor and a licensee.

Key Takeaways

  • A licensing agreement allows one party (the licensee) to use and/or earn revenue from the property of the owner (the licensor).
  • Licensing agreements generate revenues, called royalties, earned by a company for allowing its copyrighted or patented material to be used by another company.
  • Some examples of things that may be licensed include songs, sports team logos, intellectual property, software, and technology.

Understanding Licensing Agreements

Licensing agreements delineate the terms under which one party may use property owned by another party. While the properties in question can include a myriad of items, including real estate holdings and personal possessions, licensing agreements are most often used for intellectual property, such as patents and trademarks, as well as copyrights for written materials and visual art.

Licensing agreements are widely used for the commercialization of new discoveries or technologies.

In addition to detailing all parties involved, licensing agreements specify in granular detail how licensed parties may use properties, including the following parameters:

  • The geographical regions within which the property may be utilized.
  • The time period parties are allotted to use the property.
  • The exclusivity or non-exclusivity of a given arrangement.
  • Scaling terms, such that new royalty fees will be incurred if the property is reused a certain number of times. For example, a book publisher may enter a licensing agreement with another party to use a piece of artwork on the hardcover editions of a book, but not on the covers of subsequent paperback issuances. The publisher may also be restricted from using the artistic image in certain advertising campaigns.

Licensing Revenues

Licensing revenues, known as royalties, are a significant source of revenue for several publicly traded companies. For example, a major source of income for the publicly-traded company Dolby Laboratories is the licensing of its technology to consumer electronics manufacturers.

The terms of royalty payments are laid out in a license agreement. The license agreement defines the limits and restrictions of the royalties, such as its geographic limitations, the duration of the agreement, and the type of products with particular royalty cuts. License agreements are uniquely regulated if the resource owner is the government or if the license agreement is a private contract.

In most license agreements, royalty rates are defined as a percentage of sales or a payment per unit. The many factors that can affect royalty rates include exclusivity of rights, available alternatives, risks involved, market demand, and innovation levels of the products in question.

To accurately estimate royalty rates, the transactions between the buying and selling parties must be willingly executed. In other words: the agreements must not be forced. Furthermore, all royalty transactions must be conducted at arm's length, meaning that both parties act independently, and have no prior relationship with one other.

Examples of Licensing Agreements

Licensing agreements are found in many different industries. An example of a licensing agreement is a contract between the copyright holders of software and another company, allowing the latter to use the computer software for their daily business operations.

An example of a licensing agreement in the restaurant space would be when a McDonald's franchisee has a licensing agreement with the McDonald's Corporation that lets them use the company's branding and marketing materials. Toy manufacturers also routinely sign licensing agreements with movie studios, giving them the legal authority to produce action figures based on popular likenesses of movie characters.

Entering Into a Licensing Agreement

The bargaining power of the two parties involved in a licensing agreement often depends on the nature of the product. For example, a movie studio that licenses the likeness of a popular superhero to an action figure manufacturer might have significant bargaining power in this negotiation, because the manufacturer is likely to profit immensely from such an arrangement. The movie studio thus has the leverage to take its business elsewhere if the manufacturer gets cold feet.

Those entering into a licensing agreement should consult an attorney because there are complexities that may be hard to grasp for those without a deep understanding of intellectual property law.